Dear Shareholder:
Enclosed is a copy of our Semi-Annual Report for the six months ended December 31, 2006. I would encourage each of you to spend a few minutes reading it as it provides valuable information about our funds and an overview of their performance.
Goldilocks Economy?: In the mid 1980s the U.S. economy entered a long period of expansion that lasted until the end of the decade. Inflation and unemployment levels were low and steady economic growth led to rising standards of living. After a brief recession that ended in 1991, the economy resumed its steady upward climb, again accompanied by low inflation, low unemployment, and steady economic growth. This phenomenon has been referred to by many as the “Goldilocks” economy because it was “not too hot (subject to inflationary pressures), not too cold (subject to a recession and high unemployment levels), but just right”. As the first quarter of 2007 unfolds, there is an emerging debate about whether current conditions point to another Goldilocks economy.
The answer to this question is a resounding “yes” or “no” depending upon to whom you are speaking. The optimists that make up the “yes” camp point to record corporate profits, an unemployment rate that’s near a five-year low at 4.5%, relatively benign inflationary pressures that appear to be moderating, and an economy now in the sixth year of the current expansion, that continues to grow at a respectable rate (the preliminary estimate of fourth quarter 2006 GDP came in above survey at 3.5%).
The pessimists that make up the “no” camp make some equally compelling arguments in support of their position. First, they point to the fact that inflation which was running at a 2.1% pace during the fourth quarter of 2006 is still too high. After all, the Chairman of the Federal Reserve, Ben Bernanke, is on record as saying that his “comfort zone” for inflation is somewhere between 1 and 2 percent. The pessimists also point to the significant correction in the housing market as further evidence of an economy that is likely to slow further as the spillover effect fully manifests itself during the coming year. And finally, the “no” camp is also quick to point out that the personal savings rate in the U.S. for 2006 fell to a negative 1 percent which is the poorest showing in over 70 years since the negative 1.5 percent savings rate that occurred in 1933 during the Great Depression.
So, who is right? Trying to read the tea leaves is always full of hazards; perhaps that is why economics has been dubbed by some as the “dismal science”. If forced to take a side in the debate, I “guess” I would align myself more closely with the “yes” camp. It feels pretty good to be a self-proclaimed optimist! All kidding aside, I tend to believe that the economy has enough positive momentum to avoid a broad-based recession and that economic growth will continue to tick along at a respectable, albeit somewhat slower pace in 2007. In its most recent statement, the Federal Reserve reiterated its belief that “inflation pressures seem likely to moderate over time”. If the Federal Reserve has it right and inflation does moderate as expected, interest rates should remain relatively stable throughout much, if not all of, 2007.
Municipal Bond Outlook: So what does such a stable rate scenario portend for the municipal bond market? In the past few weeks municipal bond yields have increased (thereby reducing bond prices) somewhat in recognition of the distinct possibility that the interest rates cuts that it had previously factored in might not come to fruition and also partially in response to a significant increase in the supply of new municipal bond issues. With the benefit of hindsight, it now looks like the municipal bond market may have gotten a little ahead of itself at the end of 2006.
The good news is that a stable rate environment helps investors earn a coupon-level total return without a lot of price appreciation. Even in periods of market volatility municipal bonds have historically been relatively stable due to their income component. It is this steady stream of tax-free income that helps smooth any bumps that you may encounter in the road.
2006 Tax Forms: By now you should have received all tax forms for 2006 with the exception of Form 5498 (IRA Contribution Information) which is sent to shareholders who made contributions and rollovers to Traditional/Roth IRAs and SEP accounts. Form 5498 is not sent out to shareholders until late May since you have until April 17, 2007 to make contributions to retirement accounts for the 2006 tax year.
This will serve as a reminder that all shareholders invested in our eight municipal bond funds who earned over $10 in tax-exempt interest received a Form 1099-INT. The amount reported in Box 8 of Form 1099-INT represents the total amount of tax-exempt income received in 2006 for a particular account. Your 2006 year-end account statement which was mailed out in early January also provides the total amount of tax-exempt interest earned in 2006 as well as a breakdown of the average cost basis for any shares that you may have redeemed during 2006.
We look forward to meeting your investment needs in 2007.
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